The ride is getting bumpier

The TED spread is high, the T-Bill yield is low, banks are disappearing, etc.  It sounds grim and it is grim.  The "bright side," if I may call it that, is that the financial sector really does need to shrink.  It is doing so at an accelerated pace.  That is one problem from having so many derivatives markets but it is also their virtue.  There may be speculative swings in price but when reality arrives you can’t run away from it.  And a high TED spread can be a good thing too, forcing banks to shrink or consolidate or shed assets.  Bank consolidation raises profits and allows retained earnings to finance activity in the former losers.  If there is any consolation, this is not Japan of the 1990s, which was the original worry of many people.

The bumps may yet destroy the sled, but what appears to be bad news can in fact turn out to be good news.  Stay tuned…


There are still over 9,000 solvent financial institutions in this country well positioned to to take over the market share of the losers and bad gamblers. As Tyler suggests, some of the defunct instituions served markets taht will no longr exists or will shrink, but that's OK. Time to repurpose.

Of course, the bail-out has now retarded the process, slowing the readjustment and confusing buyers and sellers of financial assets. The idea that the people in this video have crafted a cure is depressing.

There may be speculative swings in price but when reality arrives you can't run away from it.

For a neophyte, can you give an example of where you can run away from reality? What does that look like, and why is it not an option for derivatives?


The solution is simple, it is elegant, and it will work.

1. Force all off-balance sheet "assets" back onto the balance sheet, and force the valuation models and identification of individual assets out of Level 3 and into 10Qs and 10Ks. Do it now.
2. Force all OTC derivatives onto a regulated exchange similar to that used by listed options in the equity markets. This permanently defuses the derivatives time bomb. Give market participants 90 days; any that are not listed in 90 days are declared void; let the participants sue each other if they can't prove capital adequacy.
3. Force leverage by all institutions to no more than 12:1. The SEC intentionally dropped broker/dealer leverage limits in 2004; prior to that date 12:1 was the limit. Every firm that has failed had double or more the leverage of that former 12:1 limit. Enact this with a six month time limit and require 1/6th of the excess taken down monthly.

Once 1-3 are put in place then send in the OTS and OCC examiners and look at every financial institution in the United States. All who are insolvent and unable to raise private capital immediately are forced through receivership where the debt is converted to equity and existing equity is wiped out. With the CDS monster caged the systemic risk is removed, the bondholders provide the cushion for recapitalization (as it should be) and the restructured firm emerges with no debt while the former bondholders are now the owners (of the equity) in the resulting firm.

With a clean balance sheet the restructured firms remain in business and open the next morning able to raise and attract capital.

For the few firms that have an insufficient debt holder capital cushion to successfully complete this process, they are liquidated instead. There will be few of these and in fact each of those firms is a regulatory failure, as we should have never permitted a firm to become so far "underwater" that the bondholder's capital is insufficient to capitalize a restructuring.

Finally, drop the silly shorting restrictions. Liquidity in the market right now stinks and this is a big part of why. Start prosecuting aggressively the rumors and other manipulation that leads to stocks both rising and falling.

This plan will work, it will instantaneously stabilize the credit markets as balance sheets will be transparent, the CDS monster will be permanently de-fanged, leverage will be returned to reasonable levels and the forcibly restructured firms will have no debt on their balance sheets and be able to immediately access the capital markets.

Best of all, it will require exactly zero taxpayer dollars.

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